Beware of banking in December quarter as the numbers could lie

New Delhi, Jan. 9 -- On the face of it, the results for the third quarter of 2016-17 will show a stellar profit growth for banks simply because lenders suffered terrible losses in the corresponding quarter of the previous fiscal as the Reserve Bank of India's (RBI) asset quality review (AQR) had forced unprecedented provisioning.
Analysts expect the net profit of banks to show a jump of as much as 95% for the quarter to December, marked by a surge in treasury income and a decent net interest income growth.
Of course, treasury income is expected to be the key driver as bond yields dropped more than 30 basis points (bps) during the quarter and, in all, 65 bps from the peak to the bottom of the three months to December.
Margins will likely improve as the deluge of deposits because of the withdrawal of high-value bank notes, largely into low-cost current and savings account, would have fetched banks a decent spread of 175 bps even if they had just parked the entire money at RBI's reverse repo tenders. One basis point is one-hundredth of a percentage point.
But consensus earnings per share (EPS) estimates for 2016-17 for the BSE Bankex index have dropped 12.9% since 8 November, as pointed out in a Mint article on Friday, and this indicates the market is less sanguine on banks in the post-demonetized economy.
The worry is justified as, firstly, demonetization has not repaired the shredded asset quality fabric of banks at all; in fact, in some cases, it has made it worse. The fresh pain points on asset quality that will arise due to demonetization have been given a temporary relief after RBI relaxed classification norms. This simply means that for at least one quarter, the slippages may not worsen.
But by far the most worrying factor is the near-collapse of credit growth. Data from RBI shows loan growth dropped to 5.1%, the lowest in half a century as of 23 December. Unless disbursals pick up, this potentially spells doom for banks' future earnings, especially when their turf is threatened by the bond market and even new players.
Net interest income, the core income a bank generates through lending, will begin falling steadily in the following quarters. A surge in deposits is of no use if the money is not lent by banks to earn income.
Margins could also come under pressure unless banks begin grabbing high-yield loan assets in place of passive investments in low-yielding government securities.
In short, a clutch of good numbers such as a surge in profit growth, a rise in core income and treasury profits will give no cause for elation and worsening metrics through rise in bad loan ratios won't mean it's the end of the world for banks. Investors need to look beyond the numbers for the December quarter.